Financial Assessment Works

Financial Assessment is working. FHA’s new policy of requiring financial assessment (“FA”) of the borrower’s ability to pay has cut tax and insurance default by two-thirds and serious defaults almost in half, according to an analysis by New View Advisors.

FHA’s objective for the new Financial Assessment regulations was to reduce the persistent defaults, especially Tax and Insurance (“T&I”) defaults, plaguing the HECM program. As FHA put it, “… an increasing number of tax and hazard insurance defaults by mortgagors led FHA to establish … a requirement for a Financial Assessment of a potential mortgagor’s financial capacity and willingness to comply with mortgage provisions.” Financial Assessment requirements became effective for HECMs with case numbers issued on or after April 27, 2015. Since then, HECM lenders must make a financial assessment of the borrower’s ability to meet their obligations, including property taxes and home insurance.

T&I and other defaults can lead to foreclosure and result in significant losses to FHA, HMBS issuers, and other HECM investors. Defaults rose steadily during the financial crisis and have remained a thorn in the side of the program.

It’s been nearly two years since FA began, so we should be able to measure the effect of this policy by comparing the default rates of loans originated just after and just before the FA rule was implemented.

With this in mind, New View Advisors looked at a data set of over 85,000 HECM loans, comparing loans originated in the immediate post-FA period from July 2015 through December 2016 to loans originated in the 18 month pre-FA period from October 2013 through March 2015. After July 2015, there were few (if any) loans originated under the pre-FA guidelines. As the guidelines took effect in April 2015, the second quarter of 2015 includes a mix of FA and pre-FA loans.

The data show a very strong reduction in T&I defaults in the post-FA period. After 18 months, the pre-FA data set shows a T&I default rate of 1.17%, and an overall serious default rate of 1.80%. By contrast, the post-FA data set shows a T&I default rate of only 0.39%, and an overall serious default rate of 1.03%. For the purposes of this analysis, we define serious defaults as T&I defaults plus foreclosures and other “Called Due” status loans.

Based on this result, we should give the Financial Assessment concept high marks for reducing defaults, however this is a mid-term grade that needs to be tested further as the post-FA portfolio ages.

Average loan size and subsequent draws are also higher for the post-FA market. This is not surprising since homeowners of more expensive home generally have better credit and ability to pay. Also, FHA now limits the amount that can be lent in the first 12 months. As the recent month of HMBS issuance shows, subsequent draws and HMBS “tail” issuance are a driving force in the industry’s profits.

Given these trends, estimates based on unit counts of HECM endorsements overstate the negative impact of financial assessment. Measuring by dollars lent, and not just at initial loan funding, is the true metric by which we should measure industry growth.

On a side note, this is New View Advisors’ 100th blog dating back to June 2009, a modest milestone, but a milestone nonetheless.

(Note: This article was published with permission from New View Advisors, which compiled data from publicly available Ginnie Mae data as well as private sources.)